Good morning. My name is Andrea, and I will be your conference operator today. At this time, I would like to welcome everyone to the Novanta Incorporated's 2023 Second Quarter Earnings Call. [Operator Instructions] I would now like to turn the conference over to Ray Nash, Corporate Finance Leader for Novanta. Please go ahead.

Thank you very much. Good morning, and welcome to Novanta's second quarter 2023 earnings conference call. I am Ray Nash, Corporate Finance Leader of Novanta. With me on today's call is our Chair and Chief Executive Officer, Matthijs Glastra; and our Chief Financial Officer, Robert Buckley. If you have not received a copy of our earnings press release issued today, you may obtain it from the Investor Relations section of our website at www.novanta.com. Please note, this call is being webcast live and will be archived on our website shortly after the call. Before we begin, we need to remind everyone of the safe harbor for forward-looking statements that we've outlined in our earnings press release issued earlier today and also those in our SEC filings. We may make some comments today, both in our prepared remarks and in our responses to questions that may include forward-looking statements. These involve inherent assumptions with known and unknown risks and other factors that could cause our future results to differ materially from our current expectations. Any forward-looking statements made today represent our views only as of this time. We disclaim any obligation to update forward-looking statements in the future even if our estimates change. So you should not rely on any of these forward-looking statements as representing our views as of any time after this call. During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of such non-GAAP financial measures to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP measures in the earnings press release, we will provide reconciliations promptly on the Investor Relations section of our website after this call. I am now pleased to introduce the Chair and Chief Executive Officer of Novanta, Matthijs Glastra.

Thank you, Ray. Good morning, everybody, and thanks for joining our call. Novanta had a fantastic second quarter. In the quarter, we delivered $229 million in revenue, representing 7% year-over-year revenue growth on a reported basis and 5% growth on an organic basis. Our adjusted EBITDA was $52 million, and adjusted diluted earnings per share was $0.80. These results are better than our expectations and reflect excellent operating performance by our teams in an evolving macroeconomic environment. The Novanta business model with diversified exposure to high-growth medical and advanced industrial markets has proven resilient under multiple geopolitical and market economic scenarios. Our proprietary products and technologies are well positioned in medical and advanced industrial applications with long-term secular tailwinds such as robotics and automation, health care productivity and precision medicine. We feel that the strength and diversification of our portfolio and business model, combined with our winning growth strategy focused on where we play and how we win, drives our performance, no matter the environment. Now let's turn to what we're seeing in our markets and our customer activity. We continue to see strong ongoing demand from our customers in many application areas. Our teams made great progress reducing our past due backlog to customers by more than 46% sequentially, while still maintaining a backlog of $583 million, which is still very high by historical standards. This past due reduction was better than expected and helped us deliver stronger sales costs versus our expectations as we accelerated more shipments into the second quarter versus the third quarter. Our book-to-bill in the first - in the second quarter was 0.92, which is in line with our expectations. As we discussed in the last earnings call, our teams continue to reduce our lead times for our products back to historical averages and…

Thank you, Matthijs, and good morning, everyone. Our second quarter non-GAAP adjusted gross profit was $108 million or a 47% adjusted gross margin compared to $99 million or a 46% adjusted gross margin in the second quarter of 2022. For the quarter, adjusted gross margins were up sequentially and year-over-year by more than 100 basis points. This outcome was better than our expectations and represent strong execution by our teams to achieve this result. The longest driver - the largest driver for our performance was better production quality achieved through the deployment of the NGS productivity tools in our factories. The 47% gross margin puts us on a solid track to achieving our full year goal of expanding gross margins by 100 basis points. Moving on to operating expenses. R&D expenses were roughly $23 million or approximately 10% of sales. First quarter SG&A expenses were $42 million or roughly 18% of sales and overall operating expenses as a percent of sales were flat sequentially and flat year-over-year in the quarter. Adjusted EBITDA was approximately $52 million in the second quarter of 2023 or 22.5% adjusted EBITDA margin versus $45 million in the prior year. On the tax front, our non-GAAP tax rate for the second quarter of 2023 was 18%. This differed from the statutory rate due to jurisdictional mix of income. Our non-GAAP adjusted earnings per share was $0.80 in the quarter compared to $0.78 in the second quarter of 2022, while adjusted EBITDA grew double digits, EPS continued to be muted solely to the higher interest expense from the jump in worldwide interest rates. Second quarter cash flow was approximately $23 million, up 25% versus the prior year. We expect cash flows to continue to improve through the rest of the year as we gradually bring down our…

We will now begin the question-answer session. [Operator Instructions] Our first question comes from Lee Jagoda of CJS Securities. Please go ahead.

Hi. Good morning.

Good morning, Lee.

So you touched a lot on the declines we're seeing in microelectronics and the idea that the PCBA stuff is now at a pretty low run rate. Can you comment on the remainder of the microelectronics business and the trends you're seeing there?

Yes. So what is - I would say the PCBA exposure has now declined to just a couple of million dollars at this point. So really nothing and it's bottomed out at that level. So what's remaining is products sold into the EUV DUV markets and applications. And for those areas, we're actually seeing a little bit of growth right now. And as we talked about in the last call, we expect that we'll continue to grow into 2024 and maybe even an accelerated basis because of additional business that we've been winning in that marketplace. So the overall exposure in microelectronics, as we go into 2024, in our view, is now a little bit of a secular tailwind versus the dynamic of volatility that we're seeing in 2023.

And then some of the companies that we follow here are commenting about weakness in the hospital procedure volumes. How are you - what are you seeing there? And what are your OEM customers telling you about their future volumes?

Yes. We - our customers are very bullish of upbeat about the remainder of this year and next year. So basically on the back of improved procedure growth rates that are supported by still long patient backlogs, right? And then further helped by product cycles and new product launches of our customers. And of course, for ourselves, we see new product launches coming in the course of next year as well that will further strengthen that. So we feel that this area is strong for us. Again, we play in minimally invasive surgery, robotic surgery, in vitro diagnostics, DNA sequencing. Those roll up strong double digits in the second quarter, and we expect them to remain strong in the second half of the year and 2024.

And then one more for Robert, and I'll hop back in. You mentioned the Manchester and the Czech facilities as CapEx uses in 2020 - in 2023, what's the CapEx guidance for this year? And then assuming that it goes back to a more normalized level in '24, how do you think about that range?

Yes. So we added it in the Q. So it's $25 million to $30 million is the total CapEx that we're expecting this year. As we get into next year, there might be a little carryover that, but it will start to drop then back down. I think overall CapEx as a percent of sales would probably drop closer to the 2% level on a go-forward basis. 2% of sales.

Great. Thank you.

All right, Lee. Thanks.

Next question comes from Brian Drab of William Blair. Please go ahead.

Hi. Good morning. Thanks for taking my questions.

Good morning, Brian.

Good morning. So I just wanted to clarify, in microelectronics, I understand the Westwind business. I believe, was about 2% of sales. And then we talked about that, I think it was in the fourth quarter, going to 1%. It was basically cut in half. So that's, to me, like I felt like a 100 basis point headwind. I'm just - when you talk about the $300 million to $400 million, can you just bridge that? What else is in there between the 100 basis points and then bridging to the $300 to $400 million?

It's a little bit more than that, but I would also say that it's also a fact that we also traditionally had some back-end semiconductor application areas. And so the overall - like the more volatile piece of it of our microelectronics historically have been around 10% of sales. If you look at the drop down to 7% of sales, those are the more volatile pieces of it, about 3% of sales, and they're effectively nothing on a go-forward basis. So then what's remaining that 7% is the EUV and DepEV-based applications - so that's the way you should kind of think about it. There are other exposures in microelectronics, too. We talked about the mechanical piece, but there's also a laser-based piece as well. We just - that's all kind of included in that $10 million dropping to 7%.

And in that outside of the Westwind business, the component - type of components or products that are seeing the headwind. Is that more like precision motion type of product or photonics?

Correct. Yes. More of the - so a lot of it is concentrated in this segment, in the Robotics and Automation segment. Not to say that there isn't any exposure elsewhere, it just happens to be mostly consolidated in that area.

And I guess, I mean, the slowdown you're seeing overall, I mean, you just trimmed the guidance, I guess. But I'm surprised a little bit that given the backlog that you have and that you said the past due orders are cut significantly. So you're shipping out of backlog that wasn't able to soften the blow a little bit more? I mean could you comment on that?

Yes. I would say it has softened that there was more of an abrupt change in China. China has had some volatility, both from a macro perspective as well as around their incentives and stimulus that they've been putting in. The COVID lockdown is in a little bit more of a number on the country. And so because of that, and you can see this in the PMIs and the exports in China, there was a bigger drop there. So I would say our ability to mitigate that, there's really kind of the microelectronics headwind and then the China drop has really been because of the higher backlog. Now that being said, we do expect to exit the year with two or more quarters worth of backlog. And so while we're continuing to get at those reductions, the areas where there's the greatest increase in backlog happen in our medical-based businesses. and that's somewhat hampered by the capacity of our facilities. And so as our new Czech facility comes online and our new Manchester facility comes online in early 2024, that we can start driving that higher growth coming out of the Medical Solutions part of the portfolio and a little bit more in the - in our precision medicine part of the portfolio.

Okay. Thanks. And then just the last question. I mean obviously working through the model here, but it seems clear that the fourth quarter is expected to be a good step-up from the third quarter in terms of revenue. I mean first of all, is that true? And then what kind of visibility do you - is there anything specific you have visibility to in the fourth quarter that results in that guide?

It really just depends on how you look at the range in the third quarter and the range of the full year. But to the degree that there's you have modeled more of a step-up in Q4. What is that? I think that's continued ability to reduce the fastening and get more product out the door, right? And so in other areas. We are seeing surprising resilience in some of the industrial-based applications we're serving unrelated to China. And so there's areas there where companies are making investments in the U.S. and European markets. There is a little bit of a near-shoring effect going on as well as just an increase in automation, generally speaking, because of labor shortages in those markets. And so there is a little bit of a surprising better resilience that we're seeing in those application areas that's helping us along.

Got it. All right. Thanks very much.

Thanks Brian.

[Operator Instructions] Our next question comes from Rob Mason of Baird. Please go ahead.

Good morning. Thanks for taking my questions. So I don't want to belabor this point around microelectronics, but - and maybe the other adjustments. But - so if I'm doing the math right, that's about an additional point of headwind coming out of microelectronics versus your prior guide. Then you layer on incremental China weakness. But if I look at the way your overall guide adjusted, it looks like you also increased in certain areas because those would have been more punitive. So I'm just curious what areas may have been taken up to offset some of those incremental headwinds.

Yes. I mean, as we - when you look at the back half of the year, the Precision Medicine area is actually doing quite well for Precision Medicine and Manufacturing area is doing quite well. It's expected to report high - mid- to high single digits. And that's a part of that is we got some new products in there. We have continued strength in the Laser Quantum branded products, and we have continued progress in reducing the past due performance there. And then overall, our Medical Solutions, Matthijs just mentioned how we are seeing our customers have higher demand. There is higher backlog that they're working on reducing through their end users and there is actually well on [technical difficulty] as well our JADAK branded products. So overall, we feel pretty good about that. We are seeing a little bit of growth in medical robotics year. [technical difficulty] at our end customers unrelated to us, but we are seeing growth there. So the real only negative in our portfolio right now is the microelectronics piece and then the pause in robotic spending in the China market, which is partly caused by macro condition and partly caused by pullbacks and volatility and how they've been stimulating their economy, particularly around these areas, EV, solar, battery and robotic-based investments.

Yes. So big picture, if you really look at it, Rob, right, 8% of sales in microelectronics weakness there, 9% of sales in China weakness there, but in the rest of the portfolio, a lot of resiliency and a lot of strength, right?

Just around China, Matthijs, you mentioned in your remarks a couple of times around China recovery in '24. How would you frame up your visibility on that dynamic at this point?

Yes. I mean it's a good question, right? Of course, it's - based on what we're seeing, right, you look at the structural growth drivers in robotics and automation, electric vehicles, other robotics drivers in the China market. we feel there continue to be intact. And this is kind of a pause because of an extraordinary strong year last year, right? So don't forget that. So they've probably got to handle a little bit of themselves. They're pausing. There is, of course, a business confidence weakening issue, but we do feel that, that will correct itself in 2024. Based on what we're seeing with projects in the pipeline and the comments from our customers as of this date. Again, so that's what we're seeing. And so it's more of a destocking, pausing effect, we feel that the mid and long term continues to be attractive.

And just as a last question, we're all aware of kind of the new product cycle that we'll be ramping up. You mentioned some of those products may launch by the end of the year. I'm just curious if you think about next year, does the cadence of new product releases, does that weight more towards the first half of 24 or the second half 24?

It's a matter of timing of the launch and materialization of the actual revenue itself, right? So while in medical field specifically, as we launch new products, particularly, let's say, at the end of this year and early in Q1, the reality is those products are going as part of the FDA qualification process of our end customers. And so the material - the revenue impact in the first half would be relatively muted. As we look in the second half, it begins to kind of ramp up, and it really is conditional upon how the individual customers clear through their processes. That is why when we went out with the guidance of $50 million of incremental revenue coming from our Medical Solutions area in 2025. We gave the guidance on 2025 and not 2024, knowing that 2024 had the element of volatility associated with the FDA qualifications of our customers. And so it's fair to say the back half of the year, we'll have more revenue coming from these products. But to get kind of specific around it, it's a little difficult just because of that piece of that FDA process.

I was just your release schedule favors more in the first half?

Customer by customer. So there are certain customers getting product in the first half and there are certain customers getting product in the second half. And so it really is customer by customer. And then you're talking about how the customers themselves are successful.

Yes. So it's multiple products to multiple customers throughout 2024 and then really fully ramped or close to fully ramped in 2025. That's how you need to see it. On the medical side. On the industrial side, we're also expecting an increase in the rate of launches in 2024, which will also have a little bit less large but also will have a supporting effect on growth to the company as well, yes. So we focused a lot on the medical side in the $50 million, but you kind of see that what I commented on in my prepared remarks, we're actually mostly industrial products. right? So let's not forget about that. Very good.

Very good. Thank you.

All right. Thanks Rob.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Matthijs Glastra for any closing remarks.

Thank you, operator. So to recap, Novanta had an excellent second quarter of 2023. We saw solid sales growth despite the headwinds in microelectronics and deferrals in China, industrial robotics spending. We beat our expectations for margins and profits. We've maintained a very robust level of backlog coverage while reducing our past due backlog, and we see complete strong tailwinds in our medical businesses that continue to accelerate into 2024. We're progressing nicely our innovation pipeline and are excited for the large product launches happening later this year and next year. In Novanta remains very well positioned in the medical and advanced industrial end markets with diversified exposure to the long-term secular macro trends in robotics automation, precision medicine, minimally invasive surgery and industry 40. In 2023 and beyond, we will continue to focus on new product development, design wins and high-growth applications and doubling down on moventigrosis and driving cash flows and gross margin expansion. In closing, as always, I would like to thank our customers, our employees and our shareholders for their ongoing support. I continue to be especially grateful for the dedicated efforts of all Novanta employees who work diligently every day to tackle new opportunities and manage through new challenges. We appreciate your interest in the company and your participation in today's call. I look forward to joining all of you in several months on our third quarter 2023 earnings call. Thank you very much. This call is now adjourned.

Conference is now concluded. Thank you for attending today's presentation, and you may now disconnect.